Is Now The Right Time To Buy The FTSE 100?

The FTSE 100 has been flirting with the 6,900 level for much of this year.

Only last week, the UK’s leading index hit a 14-year high of 6,898.6, just 52 points below its 1999 all-time high of 6,950.

However, the impact of inflation means that comparisons with past values are largely irrelevant, despite their claimed ‘significance’.

After all, inflation means that £6,950 in 1999 was equivalent to approximately £10,000 today, suggesting that the FTSE 100 could be 30% cheaper than it was 14 years ago.

Is the FTSE cheap?

For investors in index-tracking funds such as the Vanguard FTSE…

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The FTSE 100 has been flirting with the 6,900 level for much of this year.

Only last week, the UK’s leading index hit a 14-year high of 6,898.6, just 52 points below its 1999 all-time high of 6,950.

However, the impact of inflation means that comparisons with past values are largely irrelevant, despite their claimed ‘significance’.

After all, inflation means that £6,950 in 1999 was equivalent to approximately £10,000 today, suggesting that the FTSE 100 could be 30% cheaper than it was 14 years ago.

Is the FTSE cheap?

For investors in index-tracking funds such as the Vanguard FTSE 100 ETF (LSE: VUKE) or iShares FTSE 100 ETF(LSE: ISF), what’s important is how the FTSE is valued today — and what kind of dividend income can be expected:

FTSE 100 valuation

Current value

P/E

13.8

Dividend yield

3.4%

Source: FT

Based on these figures, the FTSE is quite modestly valued, especially as these dividends are covered more than twice by earnings, on average.

Not quite that simple

Of course, it’s not quite that simple. The FTSE 100 is heavily weighted towards the oil, mining and financial sectors.

Royal Dutch Shell alone accounts for 14.5% of the FTSE 100’s total market capitalisation, while the next ten largest companies account for another 35%. This means that if you invest in a FTSE 100 tracker, 50% of your money will be invested in just 11 companies.

Given this, I think it’s worth taking a look at the average valuations of the companies in question, listed in descending size order:

Company

2014 forecast P/E

2014 prospective yield

FTSE 100 weighting

Royal Dutch Shell

10.5

4.7%

14.5%

HSBC Holdings

11.7

5.0%

5.8%

BHP Billiton

11.9

4.2%

4.6%

BP

9.3

5.4%

4.0%

Unilever

20.3

3.3%

3.6%

GlaxoSmithKline

15.1

5.6%

3.2%

British American Tobacco

16.9

4.1%

3.1%

Rio Tinto

9.8

4.1%

2.7%

AstraZeneca

17.1

3.8%

2.7%

SABMiller

21.2

2.1%

2.5%

Vodafone

31.1

5.5%

2.5%

Source: Consensus forecasts

The largest four firms all have low valuations, which help keep the FTSE average P/E down, despite the fact that firms such as Unilever, AstraZeneca, British American Tobacco, SABMiller and Vodafone have much stronger valuations.

Looking at the figures in this way, it’s clear that not all companies in the FTSE 100 are cheap — far from it.

Is the FTSE a buy?

There’s no way of knowing what the FTSE 100 will do over the next year.

What is certain, however, is that a reliable yield of 3.4%, plus likely long-term capital appreciation, is considerably more than you’ll get from most savings accounts.

Of course, the main downside of sticking with a tracker is that you won’t be able to outperform the index — something that’s definitely possible with a portfolio of individual shares.

Indeed, the tips recommended by the Motley Fool's Share Advisor team have risen by an average of 23.8% since the service was launched in 2012, smashing the FTSE All-Share average total return of just 15.2%.

The expert analysts behind these market-beating selections have just published an exclusive new wealth report, highlighting seven simple steps you could take to boost the returns from your portfolio.

Roland Head owns shares in Royal Dutch Shell, HSBC Holdings, Unilever, GlaxoSmithKline, Rio Tinto and Vodafone. The Motley Fool UK owns shars in Unilever and has recommended shares in Glaxo. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.